The Case for Free Trade

We are seeing a seismic shift in America. In the post-World War 2 era, the United States has been a champion of free trade throughout the world, but today, America is led by the most protectionist President in 100 years. Although Americans may disagree on the benefits of free trade, widely accepted economic theory and empirical evidence are clear: free trade works.

In the seventh edition of his economics textbook, MIT economist, and former chair of the George W Bush Council of Economic Advisers, Gregory Mankiw outlines the basic economic principle that as long as an interaction is voluntary between two parties, both parties will benefit.

Think of it in terms of this simple economic model. You have a trade deficit with your local grocery store, but you do not think this is bad. Why? Simple, your grocery store has a comparative advantage compared to you when it comes to food. Sure, you could grow your own food, but it would cost far too much time and money.

The same idea applies to international trade. The goods other countries produce lets us focus on goods we are better at, allowing us to have more than we could otherwise. Let me demonstrate this visually on what is known as the Production Possibility Frontier Curve, shown below. Let us say that America produces TVs and Computers. Each goes on one axis and all the possible combinations are either on the curve or inside them. Those on the curve show maximum productivity. Let us change the scenario up. Now, America is producing TVs and China is producing computers. While it is impossible for production to be beyond the curve in the original model, production can move beyond it with international trade because the curve extends outwards.

International trade allows for each country to specialize in what it does best, which allows for more to be produced than is possible without trade.

We can see this principle in the real trade balance. Contrary to popular opinion, America still produces a lot. In fact, according to the St Louis Federal Reserve, we are experiencing record levels of production. The difference is what we produce does not have a little “Made in America” label on it. In America we produce, manufacture and assemble gas turbines, circuits, packaged medical equipment, medical instruments, and oil. All of these take an education and result in good paying jobs. In China, over twenty percent of what they assemble is telephones, broadcasting equipment, and computers. Now notice I said assembled. Most high tech parts are made outside of China, in America, Europe, Japan, and South Korea. Trade allows the US to assemble high-value goods, while China assembles low-value goods. Fifty-three percent of America’s gross output is value added, while it is only thirty-five percent in China. Free trade allows us to do what we are best at.

A 2014 World Bank study, notes that there are only two major cross-country studies which examine the effect of trade on employment. Both showed that less protectionism and more free trade leads to a lower unemployment rate, and this is not a case of reverse causation. One of the two studies even explicitly says that free trade policies increase employment in the long run. A similar study looking at trade among the developed G7 countries, also found that trade increases employment. A 2008 study from the National Bureau of Economic Research found that countries which did NOT liberalize their trade saw their income stagnate, while those that did expand trade saw their incomes grow twenty percent over fifteen years.

While trade has clear effects on employment and incomes, it also has more interesting effects. One is less war. The 19-century French Economist Frederic Bastiat is credited for saying quote, “when goods do not cross borders, armies will.” A 2009 study from the Asian Development Bank, looked at 290,040 pairs of countries from 1950 to 2000 finding the more two countries traded, the less likely they were to go to war. The implication of this is simple. The more the world trades, the more peaceful it is. By looking at data from 1960 to 2010, Dierk Herzer, a German economist, found in his 2014 paper for the German Economic Association, that increased trade leads to increased life expectancy and decreased infant mortality. His findings are supported by other economists.

Let me take you back to 2002 when the American steel industry was getting out-competed by foreign steel companies. In response, they did step up their game, but instead, they went to then-President Bush and requested a tariff to protect their inefficient industry. Because of this, American consumers and steel-using businesses had to subsidize the steel industry. For every one job, the American steel industry, there are sixty jobs in steel-consuming industries. That means, when the steel prices are raised because of the tariff, they and their consumers have to eat the cost through either higher prices or fewer jobs. According to the Wharton School of Business at Pennsylvania University, the tariff caused steel prices to rise forty percent, and cause 200,000 jobs to be lost. A classic example of a small group getting tangible benefits because many people pay a small amount.

These effects are not just limited to the steel industry. Free trade supports over five million American jobs. Similarly, the poorest ten percent of Americans, gain sixty-two of their purchasing power from free trade, while the median American gains twenty-nine percent. Protectionism is a regressive tax on the poorest Americans. It raises prices for them so those political connections can get special favors from politicians to not have to compete with foreign products they couldn’t compete with otherwise.

To paraphrase the great economist, and Nobel Leaute Milton Friedman, free trade is in the general interest of every American. While Americans are split on free trade, not one leading economist thought free trade did not have positive long-run effects on Americans when asked by the University of Chicago IMG poll of economists.